Oil and gasoline prices vaulted into record territory this week, pushing pump prices to the front of the election-year political agenda while raising fears that global demand for oil will have consumers paying $2 a gallon or more for gas for the foreseeable future.
The price of a gallon of regular gasoline yesterday hit an average of $1.95 nationally and $1.92 in the Washington area, according to AAA, formerly the American Automobile Association. In dollar terms, those are the highest levels ever, but adjusted for inflation, they are still well below the $3 reached in March 1981. But now the inflation-adjusted prices have exceeded the levels that had been the second-highest, October 1990, when Saddam Hussein's army had rolled into Kuwait.
With demand running high despite the price increases, average national pump prices are likely to hit $2.10 a gallon within weeks, and they'll stay there, said Mark A. Baxter, director of the Maguire Energy Institute at Southern Methodist University in Dallas.
"This is the economic principle of supply and demand driving prices," Baxter said. "I think this price is sustainable."
What sets this surge apart from other spikes is what one analyst called a "witches' brew" of causes, many of which will not resolve themselves.
"Addressing one factor will help a little, but it won't do it all," said Peter Rodgers, a lawyer with Sutherland Asbill & Brennan who represents oil importers.
At the root of the problem was a fundamental miscalculation by OPEC in February that international oil consumption would be dropping this year, said Philip K. Verleger Jr., an oil market economist and senior fellow at the Institute of International Economics. That was when the oil cartel announced a surprise, 4 percent cut in production starting in March. Back then, forecasters were predicting that a barrel of oil would cost $24, not $41, Verleger said.
Instead, as China's economy has boomed and the U.S. economy has recovered, demand has soared, even as supplies have been cut back. International oil demand has risen by 2 million barrels a day over January forecasts, according to the International Energy Agency. And U.S. oil imports have risen strongly, shooting up nearly 135,000 barrels a day last week alone, the Energy Department said last week.
That has depleted reserves significantly. Oil reserves are nearly 6 percent below the five-year average, according to the Energy Department, and gasoline reserves are similarly stretched. The nation's oil refineries are running flat out, at 96 percent of their capacity, and with prices so high, they are keeping as little in reserve as possible.
"Refinery runs are about as high as we've ever seen them," said S. Eugene Edwards, a senior vice president at refinery giant Valero Energy Corp. "Gasoline production is at record highs. And the [profit] margins are so good, we want to keep everything running."
Exacerbating the situation are speculative traders, jittery about the ongoing sabotage of Iraqi oil pipelines, the prospect of terrorist attacks beyond Iraq, and possible political unrest in Venezuela, Nigeria and other oil-producing states. U.S. demand for gas-guzzling sport-utility vehicles has been tempered very little by gas prices.
Also, new environmental regulations sharply reducing allowable levels of sulfur have reduced imports of high-sulfur refined gasoline from Latin America.
Venezuela used to send four to five shipments of refined gasoline to the United States a week, with up to 500,000 barrels in each, Verleger said. That extra supply met a critical demand spike during the summer driving months. Now, those shipments are down to one a week.
That source has only begun to diminish. The standards will become even tougher in 2005, and tougher still in 2006, Rodgers said.
"People believe this year's price is just a preview. It could get much, much worse," he said.
In fact, industry analysts are sharply divided about where prices are heading. Pessimists, such as Baxter, point to China's rising demand as an ominous sign. If that demand is being driven by Chinese consumers, demand will only rise. India's rapid economic growth will only exacerbate the situation. The Energy Department recently increased its forecast for oil consumption, saying demand will rise from 80 million barrels a day to as much as 120 million by 2025, with supply quantities unknown.
But the short-run spike in demand may be driven by China's booming manufacturing and processing sector, which many economists believe is due for a sharp decline, said John C. Felmy, chief economist at the American Petroleum Institute. Which it is may determine the future of gasoline prices worldwide.
"If this is economically driven, through major processing operations, we could have just a demand hiccup," Felmy said. "But if it's the wealth effect [from economic development] and people switching from bikes to cars, then we're looking at something enormously powerful. That's almost a train you cannot stop."
Others believe consumers are suffering under a speculative bubble, driven by traders who have rushed into giant commodity purchases. Valero officials said they are finding no shortage of crude to buy for their 15 refineries, but they are paying dearly for it. Given the level of supply, Edwards said a barrel of oil should be around $30, not $40.
"At some point, fundamentals will take over again, and it's going to be like a herd of elephants getting out the door," he said of the commodity traders. Verleger said he knows when: Memorial Day, when would-be travelers, spooked by high gas prices, stay home, and traders realize their expectations for rising demand were wrong.
For now, such optimism hardly seems warranted. Contracts for gasoline slated for June delivery reached the highest level yesterday since gasoline future trading began in 1984, suggesting prices are not coming down soon. A barrel of crude oil for June delivery leaped 30 cents yesterday, closing at $41.38 on the New York Mercantile Exchange.
And escalating prices have begun to pinch. The Washington radio station WHUR-FM 96.3 will give away $30 worth of gasoline to the first 96 cars that line up at its Bryant Street office this morning.
Also, bitter political recriminations have begun to fly. White House officials continue to goad Congress to pass an energy plan that will be three years old this Monday. But the White House has come into criticism not just from Democrats but even from some energy industry executives who say President Bush has done little to arrest the climb.
Edwards said consumers should vent their anger at OPEC, but also at Bush for transferring hundreds of thousands of barrels a day into the nation's strategic petroleum reserve. By signaling that he is serous about gasoline prices, the president could halt speculative oil trading, Edwards said.
"We've already got 659 million barrels" in the reserve, he said. "How much is enough?"
White House spokesman Trent Duffy responded, "That is America's emergency gas tank, and for reasons of national security, we have to make sure the strategic petroleum reserve is filled."